Last week natural gas made news after soaring past the $6 level in response to another bout of cold weather in the country.

According to Bloomberg, inventories are already the lowest in a decade, and the cold blast could cause a further drawdown of stocks.

“A much colder than normal winter sharply drew down gas inventories, pushing the expected end-of-March storage below 1-Tcf, which was last seen in 2003 when March prices spiked to $9.5,” says a research note from Citi analysts Anthony Yuen, Edward L Morse, Aakash Doshi, Seth M Kleinman, Eric G Lee, Christopher Main and Xing Xing.

Scarcity pricing!

The chart below shows the trading action last week in natural gas futures for the March contract. Note how prices have rebounded from the lows around $3.6 in November 2013.

Natural Gas phy-fut-cme

A Reuters article said that traders who were short have been forced to cover their positions and that punters ploughed in money to make a speculative quick buck. One analyst called the situation “scarcity pricing.” Indeed, investors in the United States Natural Gas Fund, LP (NYSEARCA:UNG) ETF have done well for themselves in the recent weeks, as apparent from the chart below.

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Fundamentals driving runaway gas prices: Low inventories

According to the Citi analysts, the unexpectedly colder winter caused a sharp increase in off-take of natural gas, thereby depleting inventories and causing extreme market tightness. Prices are therefore skewed to the upside.

“Now with the end-of-March storage edging down below 1-Tcf, the 250-Bcf change in inventories has tightened the market so much that $5/MMBtu gas for 2014 would be needed to both cut demand and hopefully incentivize increases in production,” says the note.

High demand in the Northeast due to low prices (compared to Henry Hub)

Low prices in the Northeast have made gas-based power generation attractive compared to coal, thereby increasing demand. The production glut out of Marcellus/Utica was only “partially alleviated” by the weather conditions, according to Citi.

Shortfall in hydro power generation on the West Coast

The Citi analysts also anticipate that low hydro generation on the West Coast could boost gas-based power generation during Q2 – in California by 0.2-0.4 Bcf/d and in the Pacific Northwest by 0.4 Bcf/d.

Lower exports of natural gas by neighbor Canada

Canada is also afflicted by dwindling storage – lower by 280 Bcf y/y, and the pressure to replenish storage could result in lower exports to the US, says the report.

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“Lower Canadian gas storage and low West Coast hydro generation could boost West Coast and Western Canadian gas prices higher, where AECO prices could rise closer to Henry Hub level in spring and summer,” anticipate the Citi analysts.